Philip Morris International: Brexit Highlights Short-Term Risks

Summary

Analyzing the company's exposure to Brexit and the EU.

Discussing future growth opportunities and risks in Asia.

Projecting dividend growth over the next few years.

Finding stable sources of income is hard. The major indexes have largely been flat over the last six months, interest rates remain low, and most leading dividend stocks now trade at a significant premium.

One of the most popular dividend and income stocks in the market is Philip Morris International (NYSE:PM). Philip Morris International has risen significantly over the last several months, but the stock has still performed poorly over the last several years.

Philip Morris International faces three main challenges. First, the company continues to struggle with a strong dollar. Second, the company is facing a margin squeeze due primarily to excise taxes and falling international smoking rates. Third, the company does not have enough exposure to the fastest growing markets in Asia that could enable management to offset weakness in the European Union.

Philip Morris International gets nearly 40% of its revenue from Europe, with 30% of the company's revenues coming from the EU. The company gets only about .4% of its earnings from England, and the company's earnings should not be directly impacted by Brexit in the short-term. The long-term consequence of England and perhaps other countries leaving the EU on currency markets could impact the company's earnings significantly though.

The dollar has fallen significantly over the last several months after the Fed decided to delay a summer interest rate raise, but the dollar rally is likely over. Concerns over European banks capital levels have not gone away, and fears additional countries may seek to leave the EU remain. The U.S. economy also remain relatively strong the U.S. financial system is well capitalized. If the dollar continues to rise against the Euro, Philip Morris will likely struggle to maintain even modest growth rates. Management recently guided to a 3-5% impact on earnings from currency moves, and the company has struggled to grow at more than a high single digit rate over the last several years.

The company's exposure to Yen, Australian dollar, and Canadian currency, should also create risks. The Aussie and Canadian dollar remain weak primarily because of low commodity prices, and the Japanese government has shown a willingness to intervene to lower the Yen to help exporters. Philip Morris International also faces a margin squeeze. Marlboro remains a strong global brand, but the company can only raise prices so much in countries where incomes are modest and cheaper alternatives exist. Excise taxes in countries such as Indonesia and Japan are also hurting earnings, and slow growth rates in the emerging markets will only cause these governments to seek new and higher taxes on tobacco companies in the near-term.

Philip Morris International's struggles outside of the EU continue to mount. Besides new taxes being imposed on the company's products in Indonesia and Japan, Philip Morris International has virtually no exposure in China. The Chinese government controls nearly all of the world's largest tobacco market, and allows no direct foreign competition. Foreign companies are forced to invest in Chinese tobacco brands, and those investments remain minimal. Philip Morris International's biggest Asian market is Indonesia, where the company shipped nearly 100 billion cigarettes, as compared to around 45 billion to Japan. Still, growth rates in Japan continue to fall, and the Indonesian government continues to pursue taxation of foreign companies with falling commodity prices putting pressure on the country's economy.

Philip Morris International was originally marketed as a growth story that would not face the same regulatory and litigation risks that the company's domestic counterpart, Altria (NYSE:MO). Instead, Philip Morris International has proven to be the higher risk stock. The company continues to struggle with slowing growth in the EU and Japan, excise taxes in emerging markets, and currency issues primarily stemming from the falling Euro. The company also paid out nearly 95% of earnings in dividends this past year, with management increasingly rely on debt to raise the dividend. Philip Morris International is not a reliable income stock and the recent uncertainty stemming from Brexit is another reason to sell.

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.